Not Home Yet

Last week, when the Obama Administration sat down in Washington with the country’s biggest mortgage servicers, it was sending a clear message: it’s time for banks to be more aggressive in modifying the mortgages of troubled borrowers. But the meeting was also a tacit admission that, while the government has managed the effects of the housing crisis reasonably well, it’s had less success in dealing with the crisis itself. Even as the economy seems to be stabilizing, mortgage delinquencies continue to rise, with nearly two million foreclosure filings already this year.

To be fair, a variety of things have been tried to stop the foreclosure boom, but the results haven’t been encouraging. Last year, Congress enacted the cruelly misnamed Hope for Homeowners program: its restrictions are so tight that, in its first three months of existence, it got applications from barely three hundred homeowners. The Obama Administration has done better, rolling out a seventy-five-billion-dollar mortgage-modification program, which offers mortgage servicers financial incentives to renegotiate loans. So far, it’s managed a couple of hundred thousand mortgages, but that’s been dwarfed by the rising number of foreclosures.

These programs have struggled for numerous reasons: servicers often don’t have the ability to do renegotiations in bulk and sometimes make more money by dragging their feet; securitized mortgages make modification more complicated; and borrowers often aren’t sure if they’re eligible. But the biggest problem may be that the programs are based on a faulty assumption: that modifying mortgages makes everyone—borrowers and lenders alike—better off. The idea is that since renegotiating a mortgage saves banks the hassle of foreclosing on a house, watching it sit empty, selling it at a bargain-basement price, and so on, renegotiation makes economic sense for lenders. Give lenders a nudge to start acting sensibly, and you can stop foreclosures at a relatively small cost.

It’s a comforting idea. Unfortunately, it isn’t true. In fact, according to a recent paper by economists at the Boston Fed, foreclosing is often more profitable for lenders than renegotiating is. There are two reasons for this. First, about thirty per cent of delinquent borrowers “self-cure”—after missing a payment or two, they get back on track without any help from the bank. Second, between thirty and forty-five per cent of people who do have their mortgages modified end up defaulting eventually anyway. In both cases, modification leaves the bank worse off. Reluctance to modify mortgages isn’t always a matter of obstinacy or ineptitude. It’s a matter of profit: banks are doing what makes sense for their bottom line.

If we really want to keep people in their homes, then, nudges and renegotiations probably aren’t going to do it. We need more direct action. One option, which the banking lobby killed earlier this year, would be to allow “cramdowns”: let bankruptcy judges reduce the principal on homeowners’ mortgages. Another, even more direct option is simply to give aid to homeowners: one proposal would have the government make low-interest loans, or even grants, to people who have suffered a steep decline in income and have negative equity in their homes. That would target the aid at the people who need it most: as another Boston Fed paper shows, defaults are most likely to happen not just because interest payments are set too high but because of income shocks (usually after the loss of a job) and plummeting house prices.

Even though direct aid would likely keep more people in their homes than current measures, the idea hasn’t gained much traction, not just because Americans are wary of spending more money but also because it would exacerbate our concerns about fairness. When Obama’s current plan was floated, public support was widespread but grudging; by a two-to-one margin, voters described it as unfair to ordinary homeowners. There’s a phenomenon in charity called the “identifiable victim” effect: the best way to get people to give is to focus on one person who’s going to benefit from the donation, rather than on a large group. When it comes to government programs, though, identifiability seems to be more a curse than a blessing. No one was happy about bailing out big financial institutions, after all, but the news that a group of A.I.G. employees were going to get bonuses really set people off. In a similar way, while voters may reluctantly support making refinancing easier or helping people lower their interest payments, they’re likely to balk at the idea of literally paying the mortgage of the guy down the street.

That may change if the foreclosure crisis deepens and if the slow pace of modifications doesn’t pick up. Foreclosures, after all, have a sizable impact on surrounding homes—one estimate suggests that the foreclosures in this crisis have erased two hundred billion dollars in property value—so the case for more direct action isn’t just an altruistic one. And if direct aid is too unpopular there are other interesting ideas around; the economist Dean Baker, for instance, has proposed that delinquent homeowners lose all the equity in their homes but be allowed to stay in them and pay rent instead. It seems more likely, though, that we’ll just keep muddling through with the current approach, which offers us the sense that we can get quite a lot without spending much. Maybe it’ll work. But the housing bubble was very expensive. It’ll be surprising if we can deal with its consequences on the cheap. ♦

James Surowiecki is the author of “The Wisdom of Crowds” and writes about economics, business, and finance for the magazine.